Taking out a business loan sounds pretty straightforward—until you realize just how many business financing solutions are out there. The truth is, business financing is not one-size-fits-all. Business loans come in all shapes and sizes, and each product is designed for a particular need, situation, or business model.
So, you don’t just pick a business financing solution out of a hat. Not when taking out the wrong loan product can easily do more harm than good. The trick is finding a product that’s the right fit for your business. And that means considering several factors, from the loan’s purpose to repayment terms.
Choosing a business loan can be overwhelming, especially for small to mid-sized businesses (SMBs) and start-ups that might have limited options. This guide will take you through the basics of selecting an ideal financing product: the thought process behind taking out a loan, the key factors to consider, and the pitfalls to avoid.
Let’s get started.
Why do you need financing?
Before choosing a loan, ask yourself why you need to borrow money in the first place. If you’re considering taking a loan, it’s obvious that your business needs a cash injection. But how do you plan to spend the money? You can get a business loan for any number of reasons. A loan may come in handy in the following ways:
- Increasing working capital and cash flow
- Purchasing business equipment or machinery
- Stocking up on inventory or raw materials
- Funding special projects
- Covering unpaid invoices
- Investing in real estate
Understanding the need for a loan is the first step in narrowing down the right product for your business. For instance, some loan structures only fit particular funding needs such as real estate investments, equipment purchases, or day-to-day expenses.
However, understanding a loan's purpose goes well beyond figuring out what to do with the money. Consider also the business value that the loan brings to the table. Will the cash help your business grow, increase its profit, make a worthwhile investment, or take advantage of a unique opportunity? It’s all well and good if it does.
But if you're taking the loan as a last-ditch effort to save your business, you have bigger problems than choosing a financing product. The last thing you want to do is apply for a loan out of desperation or without a clear picture of how the money will help your business recover from a financial jam and flourish.
How much do you need and when?
SMB loans come in many different sizes. It's up to you to decide how much money to borrow and how you'd want it disbursed. For example, if you're making a huge equipment purchase, you'll need a sizable lump sum. But if you’re looking to fund a construction project, it might make more sense to have the money delivered in multiple stages throughout the project.
When deciding the loan amount, keep in mind that a bigger loan means bigger repayments and higher fees. But one comprehensive loan is usually more economical than many smaller ones and is easier to manage.
The important thing is to take out the amount you need and can afford to pay back—not as much as you can get. Run the numbers carefully so you don’t end up with excess cash that will only cost you unnecessary fees and interest. You also don’t want to get too small a loan and have to seek more funding to top up the deficit.
Explore your financing options
There are many different financing options available to small and medium-sized businesses. Here's a list of the most common solutions you can leverage to fund your enterprise:
- SBA loans – These include the 7(a), microloan, 504, and disaster loan programs. These loans generally have favorable limits, rates, and repayment periods but rather strict qualification criteria.
- Line of credit – This gives you access to a reserved pool of funds from which you can draw the cash you need (within the limit) at any time.
- Term loan – The funder lets you borrow a lump sum and repay via regular weekly or monthly installments over a stipulated period.
- Business credit cards – These work in the same way as personal credit cards. They're ideal for covering small day-to-day expenses to keep the business going.
- Invoice factoring – Technically, factoring is not a loan. The funder buys your invoices for cash at something like 85% of their value. It's a way of instantly liquidating invoices before they’re due.
- Asset/equipment financing – The funder finances up to 100% of the cost of an asset and recoups the cash (with interest) through a leasing or repayment plan.
- Merchant cash advance – The funder gives you a loan and takes a portion of your daily credit or debit card sales as repayment. This arrangement suits retailers with high sales volumes.
Financing terms and requirements
Loan requirements are a major factor in selecting a financing solution. In fact, strict requirements are one of the main reasons most SMBs shy away from bank loans. Some lenders require proof of creditworthiness for certain types of financing in the form of:
- Good business credit
- Collateral (for secured loans)
- Solid business plan
- Well-resourced balance sheet
- Rich cash flow history and projections (including profit and loss statements)
- Proof of business credibility
In addition to the requirements, you need to understand the terms stipulated in a financing deal. Some loan terms are business-friendly, while others favor the lender. But the important thing is to select a loan product with terms that align with your cash flow, financial power, and business model. Here are some of the key provisions you should look out for in a loan agreement:
- Loan limit – The maximum amount you can borrow.
- Interest rate – It could be variable, fixed, or compounded interest.
- Factor rate – Represents the cost of various funding solutions (expressed as a decimal number).
- Loan term – How long you’ll repay the loan.
- Grace period – A period where you don’t have to make loan payments, usually right after taking the loan.
- Repayment plan – How you’re going to repay the loan, which could be in installments, as a lump sum, through revenue cuts, or something else.
- Penalties and fees – You might be penalized for early or late repayments. Also, the lender might charge a loan processing fee or additional fees during the loan term.
- Default terms – Stipulates what happens when you miss payments or can’t repay the loan altogether.
Loan terms and requirements vary between different loan products. That's why it's important to shop around the financing market and compare quotes from multiple lenders before settling on a financing product. However, you can also negotiate with the lender for better terms.
How to get the best SMB loan deals
There is a much better way to compare financing solutions and get the best loan deals than painstakingly scouring the financing landscape and haggling with lenders. Lendzero gives you a list of all the financing options available to your business in just one click. What’s more, we pre-negotiate all the loan terms on your behalf to ensure you get the best possible deals. Sign up today and save yourself a ton of trouble and time in financial bargaining.
